On Wednesday, the governor of the Reserve bank, Glenn Stevens, appeared before the House of Representatives economics standing committee and suggested monetary policy has done as much as it can to stimulate the economy.

Despite rising unemployment and lower than expected economic growth over the next year, Stevens believes lower interest rates are not the answer. He also effectively ruled out introducing any limits on bank lending which might encourage greater lending to businesses and enable rates to be cut without further heating up the housing market.

There has been a live experiment into the efficacy of monetary policy over two and half years. During the GFC, a large government’s stimulus package to boost the economy didn’t deter the RBA from cutting interest rates further – it cut by 425 basis points over just eight months from 7.25% to 3%.

Since November 2011 the RBA has again cut rates by 225 basis points from 4.75% to 2.5% during a time when the government showed little intention to help carry the load of stimulating the economy.

Whereas in 2009-10 annual growth in public demand – the impact of government spending on the economy – rose by 7% (easily biggest in the past 20 years), since 2011-12, despite interest rate cuts, public demand has grown by well below the 20-year average of 3.5%. The May budget confirmed that public demand actually declined in 2012-13:

Thus, with the government doing little to stimulate the economy through spending, it has been pretty much left to monetary policy to provide any boost. But despite economic and employment growth being below trend, Stevens told the committee he didn’t think lower interest rates “are the answer at the moment”.

Given his statement was in response to discussion of low consumer confidence levels and revised-down growth forecasts for next year, it would seem monetary policy has not worked as well as the monetary policy fans would like.

Certainly, the low interest rates have had an impact on construction. Building approvals before November 2011 were falling, but have since risen significantly:

But the boom in building approvals does seem to have peaked around December last year – mostly due to the decline in apartment blocks and other “non-house” dwellings.

The increase was the desired outcome for the RBA. Building jobs in construction was among the main aims of low interest rates. And while the number of building approvals appears to have peaked, the lag in time taken to go from getting a loan to actual building means there should be a strong level of work still to be done over the next 12 months.

Another aim of lowering interest rates is to lower the exchange rate. If Australia’s interest rate offers lower returns compared to other nations, the hope is investors will demand fewer Australia dollars and thus the value of the dollar will fall. A lower dollar makes Australian exports cheaper, and means our businesses are better able to compete in international markets.

The initial rate cuts in November and December 2012 did little to shift the value of the dollar. After brief drops, it rebounded and for most of 2012 it remained above parity with the US dollar:

The cut in May 2012 of 50 basis points, combined with what was seen to be an austere budget position, led to the Australian dollar dropping from $US1.03 to US$0.90 in three months.

But since the start of this year the dollar has risen again. As Stevens noted in his opening statement, “the exchange rate, another channel through which monetary policy usually has an effect, is probably not doing as much as it might usually be expected to do in achieving balanced growth”.

If we take a broader view, it is clear that employment growth has taken a while to react to the lower interest rates:

Both total and full-time employment growth showed little response to the cuts, and both dropped significantly once the round of cuts stopped in August last year.

While employment has recently shown signs of improvement, at around 1% annual growth, it remains weak.

So if building approvals seem to have peaked, the dollar remains high and employment growth is still so low that an unemployment rate above 6% seems likely for the next 12 months, why not cut rates more?

The main problem is the biggest direct impact from interest cuts: housing prices.

According to the ABS residential housing price index, housing prices in Sydney are 27% higher than they were in November 2011. In Perth they are 15% higher and in Melbourne 12%.

And herein lies the issue. Low interest rates can fuel higher borrowing for houses, but ideally they would also lead to higher borrowing by small businesses either to expand or to start up – and thus employ new people. Stevens in his opening remarks called for more “animal spirits” from businesses to take risks and make use of the low rates on offer.

But as Stevens noted, banks have been reticent to lend to small businesses since the GFC. He suggested “banks are getting less conservative, actually, at the margin on business lending. I think they are trying harder now than they were, because they want growth themselves”.

A look at credit growth data, however, shows the real growth since rates were cut has come from investors in the housing market rather than businesses or even owner-occupier housing buyers:

Further lowering interest rates under the current arrangement would likely increase housing investment – and thus prices – even were it to foster some increased business investment.

One way around this would be to make use of macro-prudential tools that could see limits placed on riskier/speculative housing lending, and encourage lending to businesses. This would in turn allow interest rates to be cut further (and help lower the exchange rate) without fuelling a great binge of housing prices.

Stevens made it clear he is not in the macroprudential camp – despite not ruling out the chance that the Australian Prudential Regulation Authority (APRA) might implement such tools. He referred to them as the “dreaded macroprudential tools” and “the latest fad”.

Perhaps we are asking too much of monetary policy.

The deputy governor, Dr Philip Lowe, noted that “at the end of the day, monetary policy cannot be the engine of growth in the economy. We can help smooth out the fluctuations, but we cannot in the end drive the overall growth in the economy”. Instead he suggests “we need to invest more, and more effectively, in education, in human capital accumulation and in infrastructure. Risk taking, education and infrastructure are the things that are going to help us be a high-wage, high-productivity, high value-added economy.”

But if the current lending system is holding back that risk taking, through banks preferring to lend to those investing in housing rather than business, then perhaps the limits of monetary policy have not been met, and macroprudential tools might provide a chance to keep firing the engine of the Australian economy.